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A Keynesian Look at the Minimum Wage

We are always hearing about stagnate wages for the middle and lower class, but in a lot of cases wages are decreasing in real dollar terms.

What the graph shows is since the 1960’s the real dollar value of the minimum wage is actually decreasing. This means even though nominal wages have been increasing their purchasing power is decreasing. To put it more simply, putting in a days work in 60’s meant you could buy milk and bread but now it means you can only buy the milk or the bread (I know this is totally over simplified but it is the gist of the issue).

What does this mean for the economy? It means the normal consumer cannot buy as much as they used too. Decreasing real wages decreases aggregate demand. Any Keynesian economist will tell you the way out of a recession is to increase aggregate demand. One way of doing this is by purchasing more products. More consumption means suppliers have to produce more which means they will have to hire more people which leads to more people having more disposable income and the cycle then repeats itself. This cycle operates much more efficiently with a higher minimum wage. It also demonstrates why it is beneficial for people to be able to buy both the milk and the bread.

Another reason raising minimum wage increases aggregate demand is due to what Keynes called the multiplier effect. This means a portion of every dollar spent is actually re-spent elsewhere. A simple example is when you go to a restaurant and leave a tip. You leave the tip presumably because you were provided a service. That tip is then spent by the waiter or waitress somewhere else. So that ‘one dollar’ boosts the economy by much more than just one dollar.

When we see real wages decreasing it is not surprising the economy is growing so slowly. A large portion of the population who buys normal goods simply cannot afford them. Reversing this trend in real wages could be a possible spark to this economy.

In a Keynesian model, unemployment is caused by downward nominal wage rigidity– firms have problems cutting wages in response to a decrease in AD during recessions. How, then, does making the nominal wage rigidity worse via a (higher) minimum wage not increase unemployment?